Directors, HMRC V Gradidge proves naivety is no excuse if MSC debts get transferred to you

At the moment, nothing seems to be attracting more commentary -- bar perhaps government ministers coming and going -- than HMRC blowing the dust off the Managed Service Company (MSC) legislation.

A new and unique MSC legislation case

Every move of the Revenue reviving the 15-year-old legislation is being reported and analysed, largely around its ongoing enquires into two accountancy service providers.

Yet in the midst of the current HMRC activity is a new and unique case that has just been decided by the First-Tier Tribunal and it deals with the legislation’s complex transfer of debt provisions. It’s the case of Nigel Victor Gradidge v HMRC, writes David Harmer, associate director at Markel Tax.

Controversial, far-reaching, exacting

What is particularly interesting about this case is that the point at issue was not whether the Managed Service Companies legislation applied (it did already), but rather whether the Transfer of Debt regulations applied. These are the regs which were enacted within the MSC legislation itself.

The MSC legislation was somewhat controversial when it took effect back in 2007, as within its provisions it included far-reaching and exacting transfer of debt provisions. The effect of which means that in the event that HMRC is successful in determining a company is a managed service company, it can, in certain circumstances, transfer the debt of that company onto other persons.

The provisions at 688A provide that those persons are:

(a)     a director or other office-holder, or an associate, of the MSC,

(b)     an MSC provider,

(c)     a person who (directly or indirectly) has encouraged or been actively involved in the provision by the MSC of the services of the individual, and

(d)     a director or other office-holder, or an associate, of a person (other than an individual) who is within paragraph (b) or (c).

Gradidge v HMRC

In this case, the MSC liability had already been established on Mr Gradidge’s company, N19 Training Services Ltd, and the MSC Provider was Think Accounting Ltd (TAL) which subsequently became New Wave.

As HMRC had no reasonable prospect of recovering the monies from Mr Gradidge’s company, the tax authority issued a transfer or Debt Notice on Mr Gradidge, as director of the MSC, to pay the liability.

This appeal was a little unusual. Mr Gradidge contended that he was unaware that he was a director of the limited company, and in any event he was not a director at the time the debt transfer notice was issued. 

What was Gradidge’s evidence to the FTT?

The facts of this case are particularly pertinent in the current MSC climate. 

In evidence Mr Gradidge confirmed:

  1. He was referred to TAL by his agency to set up a limited company. He picked the name.
  2. He recalled signing some forms within the ‘welcome pack’ authorising TAL permissions. He did not, however, sign the engagement letter with TAL.
  3. He contacted HMRC to confirm if operating through a limited company was acceptable (as he had previously been an employee).
  4. He didn’t notice any significant difference in his income, and assuming TAL was complying with all his taxes, he didn’t check his payslip.
  5. He resigned as director from the company after HMRC initiated its enquiry. In his opinion, he was never a director in the first place, just a worker of a limited company.

Ultimately Mr Gradidge lost his appeal. The tribunal established that he was director of the company at Companies House at the time the debt accrued, and therefore the fact he resigned as director prior to the issue of the transfer of debt notice did not matter.

‘Looking for fairness’

What is of further interest in this case is that the judgment makes specific reference of Mr Gradidge’s submission. At paragraph 37 of the judgment, tribunal judge Anne Fairpo makes the following comment:

I note that it was submitted that Mr Gradidge was a victim of others, that he had no choice but to use this structure as it was required by those who would provide him with work, and that he had no idea what was going on. Mr Gradidge was therefore “looking for fairness” from the Tribunal.

The tribunal expressed sympathy with this. However, the FTT noted HMRC had not sought to apply penalties, and said it did not believe Mr Gradidge was knowingly part of arrangements to avoid tax. Nevertheless, judge Fairpo further commented:

The purpose of this legislation is clearly to ensure that those who benefit from this type of arrangement, even without specific intention to do so, should be liable in order to ensure a ‘level playing field’.'

What can contractors learn from Gradidge Vs HMRC?

Firstly, it is important to highlight that in this case the MSC enquiry itself had already been decided.

Secondly, and with specific reference to the transfer of debt provisions outlined above, if HMRC reasonably believe monies are irrecoverable from the MSC itself within a reasonable timeframe, then, under normal circumstances, they can seek to apply the debt to either a director or other office-holder, or an associate, of the MSC, see s688A(a) and an MSC provider (b) referenced above, or indeed both. 

Here, however, TAL no longer existed and as such HMRC had no option but to issue the notices under provision (a). HMRC can only consider s688A (c) and (d) if monies are irrecoverable from (a) and (b).

The enquiry; the liability, the defence? It’s all yours, directors

What is clear from this judgment is that naivety is no excuse in tax! 

While most people will sympathise with Mr Gradidge, the legislation is specific and exacting.  Under the MSC legislation the liability hits the MSC (the PSC). It does not fall to the MSCP, and indeed cannot be passed to the MSCP until HMRC is satisfied it cannot be reasonably recovered from the MSC. And if the MSCP is no longer trading or capable of paying the bill, it will fall to the director of the MSC, as it did in this case, landing Mr Gradidge with a personally payable tax bill of £31,024.

The implications of this judgment may cause concern to many contractors, and there are likely ContractorUK readers who see many similarities with the facts of this case and their own/current position. We would therefore urge any contractors currently caught up in active MSC enquiries to not rest on their laurels. The enquiry is yours, the liability is yours, you must defend your position – you do not need to wait for any potential MSCP to have its arguments with HMRC, they are not directly in the line of fire; you are.

Finally, the best form of defence is attack

As we have said previously in relation to the MSC legislation, the best form of defence is attack. So be proactive, gather information now and prepare to argue your case with HMRC, especially now you know that they are flexing their muscles by using the debt transfer provisions. Finally to clarify, while we would always recommend seeking professional advice as MSC legislation is particularly complex, the most important thing you can do is appeal and take pro-active steps to defend your position – ever mindful of HMRC being backed by the courts when it comes to transferring debts to you as individual.

Tuesday 12th Jul 2022
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Written by David Harmer

David began his career with Markel Tax at 18 and has since spent 10 years with the business, completing a law degree and working his way through the ranks of tax consultant to director. Defending tax payers against HMRC challenges on all areas of contentious tax law including IR35, self-employed status, CIS, agency legislation etc., his tribunal victories include the well-known Sherburn Aero Club case.
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